Loan-to-Value (LTV) Ratio
What it is:
The loan-to-value (LTV) ratio is a calculation that helps lenders measure mortgage risk. The formula to calculate the loan-to-value ratio is:
Loan to value = Mortgage amount / Appraised value of property
How it works (Example):
For example, let's say Jane Doe wants to buy a house for $500,000. She plans to put $70,000 down and finance the rest ($430,000) with a mortgage. Using the formula above, her loan-to-value ratio would be:
Loan to value = ($500,000 - $70,000) / $500,000 = 86%
Borrowers whose LTV ratios are over 100% are considered "upside down" on their mortgages. That means they owe more on the house than the house is worth.
Why it Matters:
All other things being equal, the higher the LTV ratio, the riskier a mortgage tends to be from the perspective of a lender. This doesn't always mean the lender will reject the borrower. Rather, it may mean the lender may charge a higher interest rate or require the borrower to purchase mortgage insurance.
Typically, lenders require borrowers to buy mortgage insurance if the LTV is above 80%. FHA lenders may require LTV ratios of 96.5% or lower; VA lenders may allow for a 100% LTV, meaning those lenders are willing to accept considerable risk (usually because the government is guaranteeing the loan in whole or in part)
